International Journal of Science and Research (IJSR)

ISSN: 2319-7064
ResearchGate Impact Factor (2018): 0.28 | SJIF (2019): 7.583

Prospects and Challenges of Foreign Banking Entry

to Ethiopian Financial Market
Matiwos Ensermu
PhD, Associate professor of Management, Currently teaches at Addis Ababa University, College of Business and Economics, School of
Commerce

Abstract: Based on Ethiopia Government’s major policy shift in 2018 to partly privatize major state owned enterprises like
ethiotelecom, Ethiopian Airlines, , the preparation to introduce stock market in Ethiopia by 2020, is an indication to help expect the
possibility of allowing foreign banks to operate in Ethiopia in the future . Allowing foreign banks to operate in Ethiopia will bring both
prospects and challenges to the incumbent state owned commercial and private banks in particular and the financial sector in general.
As evidenced from literature, foreign bank entry to the domestic market will bring immense opportunity to the Ethiopian banking
market, and create strong competition challenge between foreign and domestic banks and within the domestic banking institutions.
Accordingly four strategies are recommended to be adapted by local banks in Ethiopia to follow either of: merger and acquisition,
niche, do nothing, and joint venture, with merger and acquisition as an optimal strategy.

Keywords: Foreign banking, entry, merger &acquisitions, Ethiopia

1. Background of the Study 2. The Ban on Participation of Foreign

Ethiopia is the second most populous country in Africa next
to Nigeria with estimated population size of 107 million in
2018. With the recent government’s major decision on the
part of the privatization of major state owned enterprises
including telecom, airline, shipping and other industries,
many are curious about what prospects and challenges are
going to face on financial service industry of Ethiopia if it is
allowed for foreign banks to enter and operate in the
country. Consequent to the privatization of major state
owned enterprises previously owned by the government as a
monopoly, Ethiopian nationals previously denied of share
ownership in Ethiopian banks seem to be allowed to own
and or invest in the Ethiopian banking sector pending the
approval the Parliament. Before the grand decision made by
the government in 2018, Ethiopian Government is known
for its protectionist approach when it comes to the finance
sector not to be owned by Ethiopian born foreign nationals
let alone allowing foreign banks to operate in Ethiopian
banking market. However, based on the major policy shift in
the decision of the government to partly privatize major state
owned enterprises like ethiotelecom, which is seemingly
enjoying abnormal profit with trade off of company
competitiveness; and the inclusion of Ethiopian Airlines,
which is also a national flag carrier and Africa’s pride and
worlds class organization with successive success history as
a candidate for partial privatization, the preparation to
introduce stock market in Ethiopia by 2020,etc is naïve not
to deduce the possibility of allowing foreign banks to
operate in Ethiopia . Allowing foreign banks to operate in
Ethiopia will bring both prospects and challenges to the
incumbent state owned commercial and private banks in
particular and the financial sector in general. Therefore, this
paper analyzes the prospects and challenges of allowing
foreign banks in Ethiopia and the strategies to be adapted by
domestic banks in Ethiopia to survive and thrive with the
new competitors entering and competing with them.
Volume 9 Issue 9, September 2020
www.ijsr.net
Licensed Under Creative Commons Attribution CC BY
Paper ID: ART20198790 DOI: 10.21275/ART20198790
Investment in Banks in Ethiopia
The Ethiopian banking sector has remained closed to foreign
investors. It is known that the banking sector is among areas
of investment exclusively reserved to Ethiopian nationals.
As per Art. 9 of the banking business proclamation No.
592/2008 reasserts the exclusion of foreigner investors and
other domestic investors by stating that “foreign nationals or
organizations fully or partially owned by foreign nationals
may not be allowed to open banks or branch offices or
subsidiaries of foreign banks in Ethiopia or acquire the
shares of Ethiopian banks [1]. This pervasive provision
asserts the continuation of banking business as exclusive
domain of Ethiopian nationals and their own business
entities. While the usual form of foreign participation in the
banking sector is via opening branches or subsidiaries of
foreign banks, the law does not give any loophole for
foreign participation even by way of equity holdings [2].
Governments liberalize their banking markets in order to
attract new capital and to promote the restructuring of their
often rather inefficient banking systems. One possible
channel for how foreign banks may foster such a
restructuring process is spillover effects from foreign to
domestic banks, another possible channel could be the
increase in competition. However, the opening up of
banking markets can also entail large risks since domestic
banks need to undertake huge investments to become
competitive with foreign banks [3]. At any rate in the
context of Ethiopian law, the balance of pros and cons of
foreign participation in banking has gone in favor of
exclusion of foreigners. Ethiopian financial sector, Ethiopian
Government and other stakeholders, including the leadership
of the private banks and the Ethiopian Bankers’ Association,
have five main concerns raised on Ethiopian Financial sector
[4].
a) The government believes that the development of a
viable domestic banking sector will be threatened by
foreign banks, because they have more capital, more
experience, and better reputations. They argue that the
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 International Journal of Science and Research (IJSR)
ISSN: 2319-7064
ResearchGate Impact Factor (2018): 0.28 | SJIF (2019): 7.583
Ethiopian financial sector is too young and inexperienced
to compete (the infant industry argument). Ethiopian
government officials also believe that entry by foreign
banks will further skew credit allocation towards large-
scale industrial, real estate and service enterprises
(including trade) and away from agriculture, small-scale
and cottage/micro enterprises (sectors which are the
priorities for the government’s development strategy).
b) They contend that foreign banks will concentrate lending
in major urban centers using foreign funds, contributing
little towards the development of rural banking.
Furthermore, they contend that foreign banks will
“cherry pick” the best companies and sectors.
c) Domestic savings mobilization has been identified as an
area of concern to Ethiopian officials, who have
suggested that foreign banks would lend in their home or
other foreign currencies and would not be interested in
mobilizing domestic savings.
d) There is concern that foreign banks may serve as
conduits for the inward and outward flows of capital
(e.g., through capital and money-market transactions;
credit operations; personal capital movements; etc.). This
may cause foreign exchange and/or liquidity shortages,
with potentially adverse effects on the country’s capital
account. The concern becomes more pronounced in view
of the limited regulatory capacity of the central bank.
e) Finally, it is strongly believed that the authorities will be
unable at present to regulate and supervise foreign banks
effectively.
3. Positive Effects of Foreign Bank Entry
a) Credit Availability:-Financial integration allows capital
to flow from capital-abundant countries, where expected
returns are low, to capital-scarce countries, where
expected returns are high. [5]
b) Sounder Lending Practices:-Foreign bank presence may
contribute to the stability of available lending by
diversifying the capital and funding bases. [6]
c) Competition, Stability, and Dynamic Effects in the
Banking System:-In developing countries, foreign bank
entry may stabilize the financial system. First, foreign
banks have sounder lending practices and accumulate
fewer bad loans. In addition foreign banks may be more
resilient to negative shocks because of their direct access
to foreign savings [7]. On the other hand, foreign banks
may introduce more volatility in lending because they
can more easily find alternative investment opportunities
[8].
d) Enhancing Banking Market Competition and Efficiency:-
Empirical evidence shows that foreign bank entry leads
to greater efficiency in the functioning of national
banking markets, with positive welfare implications for
banking customers. The relaxation of restrictions on
foreign bank entry may similarly reduce domestic
banking profits and force domestic banks to cut costs, but
with positive overall welfare implications for the
domestic economy [9].
Volume 9 Issue 9, September 2020
www.ijsr.net
Licensed Under Creative Commons Attribution CC BY
Paper ID: ART20198790 DOI: 10.21275/ART20198790
4. Challenges of Foreign Bank Entry
a) Tendency for Bank Crises
There is a thesis on foreign banks that these banks will be
more likely to shift their funds to more attractive markets
during a crisis if their parents are weak. There are two
related issues here: (i) whether the presence of foreign banks
makes systemic banking crises more or less likely to occur,
for example, by providing an additional avenue for capital
flight, and (ii) whether there is a tendency for foreign banks
to “cut and run” during a crisis. On the other hand, foreign
banks can contribute to the stability of the domestic financial
system, for example, if depositors shift their deposits to
foreign banks from their risky local banks rather than
engaging in a capital flight [10].
b) Challenging the Performance and Weakening
Domestic Banks
The main argument against an early market entry of foreign
banks is the risk that domestic financial institutions would
not be able to withstand increased competitive pressure and
might even risk facing bankruptcy. Such banking failures
might have spillover effects on other banks and could
possibly endanger stability in the financial market. [11] If
domestic banks fall under the “too big to fail” category and
thus require some support, suppressing competition from
new entrants can be an inexpensive form of support.
5. Forms of Foreign Bank Entry and Form of
Organization
Empirical evidence shows that in emerging markets, foreign
banks are more profitable and more efficient than domestic
banks, while being less profitable in more developed
countries [12].
a) Representative Offices:-A representative office is the
most limited but most easily established organizational
form. It does not engage in attracting deposits and
extending loans, but is generally established to test the
possibility of further involvement [13].
b) Foreign Branch:-A foreign branch constitutes a higher
level of commitment than a representative office or
agency. The crucial difference between a foreign branch
and a foreign subsidiary is that, legally, a branch is a
unity with its parent and a subsidiary is an independent
legal entity.
c) Bank Subsidiaries:-Bank subsidiaries’ are separately
incorporated from the parent bank, whose financial
commitment to the subsidiary consists of the capital
invested. Subsidiaries are usually involved in retail
banking markets.
d) Establishing an Affiliate Relationship or Participating in
a Joint venture:-This can be another way to engage in
foreign expansion. This usually involves taking minority
stakes in local entities, and the level of involvement in
the management of the local banks by the foreign bank is
normally low. The joint ventures modes are formed by
more than one firm. They generally have a financial
interest and a board membership. A joint venture is an
arrangement where the firm is required to share equity
and control of the venture with a partner from the host
country.
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 International Journal of Science and Research (IJSR)
ISSN: 2319-7064
ResearchGate Impact Factor (2018): 0.28 | SJIF (2019): 7.583
6. The Future of Ethiopian Banking Sector
Ethiopia has taken a cautious approach towards the
liberalization of its banking industry. For all intents and
purposes, its industry is closed and generally less developed
than its regional peers [14]. Foreign bank entry in Ethiopia
could introduce new banking technologies, financial
innovation and promote financial development. In addition,
it enhances access to international capital and may
precipitate the overseas expansion of domestic banks and
greater integration of Ethiopian banks into international
financial systems, which may enable them to provide a
broader range of services, particularly to larger local firms
with international operations [15]. On the other hand, the
stiff competition with foreign banks may threaten the
survival of domestic banks that may lead them to incur high
cost in the short run and decline in profit. In addition, it
may; bring shocks from other country, destabilize domestic
credit and may serve more productive sectors only [16].
Kiyota et al. (2007) Ethiopian banking sector is affected by
two factors that may constrain Ethiopia’s financial
development. One is the closed nature of the Ethiopian
financial sector in which there are no foreign banks, a non-
competitive market structure, and strong capital controls in
place. The other is the dominant role of state-owned banks
[17]. The Ethiopian economy would benefit from financial
sector liberalization, especially from the entry of foreign
banks and the associated privatization of state-owned banks
[18].
7. Conclusions and Lessons from Empirical
Evidences for Ethiopian Banking Industry
Ethiopian financial industry is highly regulated by a
regulatory, which relative to other private industries in
Ethiopia, proved to be successful in the last couple decades.
The conclusions and recommendations drawn for the
industry is equally important to take as a policy input for the
regulator (NBE) for informed policy decision, and executive
information for leaders of the industry as operators for
strategic decision making process that will enable both
(regulator and operator) for all possible scenarios of foreign
bank entry and set of choices (strategies) to be made among
the four strategies proposed. Based on the recent major
government decision on the privatization of state owned
enterprises, Ethiopia’s potential for becoming WTO
members with all the privileges and obligations, and most
importantly Government’s approval of African Continental
Free Trade Area Agreement (ACFTA), it is inevitable to see
for allowing foreign banks to operate in Ethiopian banking
market sooner or later. As evidenced from literature, foreign
bank entry to the domestic market will bring immense
opportunity to the Ethiopian banking market, and create
strong competition challenge between foreign and domestic
banks and within the domestic banking institutions. In either
of the case , as opportunity or challenge, it is a good news
for the banking industry customers as new foreign bank
entry to the Ethiopian banking market will further fuel
competition and competition will force including domestic
banks to innovate to survive and thrive. Therefore , it is
recommended that Ethiopian domestic financial institutions
should get prepared to design a strategy to enable them
Volume 9 Issue 9, September 2020
www.ijsr.net
Licensed Under Creative Commons Attribution CC BY
Paper ID: ART20198790 DOI: 10.21275/ART20198790
compete with the inevitable arrival of foreign banks to the
Ethiopian market in either or combination of the following
known strategies.
1) Merger and Acquisition: The existing state owned
Commercial Bank and first and second generation
private banks may initiate the negotiation process for
possible merger to form one or two new big commercial
and investment banks in Ethiopia, or state owned
Commercial bank may think of acquisition of emerging
recent private banks for further capital consolidation and
better competitive position.
2) Niche Strategy- though different banks may follow their
own unique strategy to be agile and survive with the
foreign bank effect, some of them can niche to specific
banking market by redefining their business mission
where they have gained new capability and possess
strong resources
3) Do Nothing- The incumbent domestic banks can
maintain the status quo and continue to operate business
as usual, hoping that the new entrants to the market will
take long time to learn , adapt and thrive in Ethiopian
banking business market. That will in turn help,
Ethiopian banks to wait and learn the behavior of foreign
banks and act on viable strategy to win competition later.
4) Joint venture-foreign banks can be perceived and treated
as potential partner to work on banking business with.
Therefore, with the assumption of win- win approach
from both sides by finding reason to partner with each
other; Ethiopian banks can opt for joint venturing with
foreign banks in ownership share mode taking in to
account the managerial control to be left in the Ethiopian
hands.
Even though, the four strategies are viable courses of action
to be taken in the context of each institution’s core
competence, if there is a necessity to prioritize among the
available four set of choices, merger and acquisition can be
considered as a first set of choice with the following
theoretical base with its own pros and cons as a strategy, as
explained below.
Every business want the optimum market share (growth)
over their competitors, so companies are trying to get
optimum growth by using the most common shortcut i.e.
Merger and Acquisition (M&A). The growth main motive is
financial stability of a business and also the shareholders
wealth maximization and main coalition’s personal
motivations. Mergers and acquisitions (M&A) provides a
business with a potentially bigger market share and it opens
the business up to a more diversified market. In these days it
is the most commonly use methods for the growth of
companies. Merger and Acquisition (M&A) basically makes
a business bigger, increase its production and gives it more
financial strength to become stronger against their
competitor on the same market. Mergers and acquisitions
have obtained quality throughout the world within the
current economic conditions attributable to globalization,
advancements of new technology and augmented
competitive business world [19]. In the last decade, M&A
are the dominant means of organization’s globalization [20].
Merger particularly could be a growing development that
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 International Journal of Science and Research (IJSR)
ISSN: 2319-7064
ResearchGate Impact Factor (2018): 0.28 | SJIF (2019): 7.583
has become an area of the recent business conditions and it’s Mary’s University, College Of Business And
apparent to possess affected each nation and trade [21]. Economics
[13] Habtamu Dagnachew(2017) Opportunities and
The merger and acquisition (M&A) reduces flexibility. If a Challenges Of Liberalizing The Banking Sector In
rival makes revolution and may currently market vital Ethiopia, A Thesis Submitted To St. Mary’s University,
resources those are of superior quality, shift is tough. The College Of Business And Economics
change expense is the major distinction between the [14] Raba, G., 2017. Prospects and Challenges of Foreign
particular merger worth and also the merchandising value of Bank Entry in Ethiopia. The International Journal Of
the firm that can be of larger distinction. Business & Management, 5(1), pp.123–132.
[15] Raba, G., 2017. Prospects and Challenges of Foreign
As a Conclusion, though one size does not match all, several Bank Entry in Ethiopia. The International Journal Of
firms think that the most effective way to get ahead is to Business & Management, 5(1), pp.123–132.
expand business boundaries through mergers and [16] Kiyota, K., Peitsch, B. & Stern, R.M., 2007. The Case
acquisitions (M&A). Mergers produce synergies and for Financial Sector Liberalization in Ethiopia
economies of scale, increasing operations and cutting prices. [17] Kiyota, K., Peitsch, B. & Stern, R.M., 2007. The Case
Investors will take comfort within the idea that a merger can for Financial Sector Liberalization in Ethiopia
deliver increased market power; stand tall to sustain [18] Leepsa and Mishra, 2012. Post-merger financial
competition from banks that may enter to the Ethiopian performance: A study with reference to select
market, and finally innovate and thrive from the manufacturing companies in India. International
consolidated resource base that is accumulated through Research Journal of Finance and Economics, 1 (83)
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[19] Weber, Shenkar and Raveh 1996 National and
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Paper ID: ART20198790 DOI: 10.21275/ART20198790 1009